EIU Global Forecasting Service

We have become more pessimistic about prospects for the US dollar

January 18th 2018

The US dollar has remained surprisingly weak in late 2017 and early 2018, softening further in spite of solid economic data, the passage of major tax reform, and another rate hike by the Federal Reserve (Fed, the US central bank). The dollar was by far the worst performer among G10 currencies in 2017.

In part, its performance reflects the comparative maturity of the US business cycle. Markets have been pricing in robust economic growth in the US for some time, but have had to make significant upward revisions to their expectations for other major economies, including the euro zone and Canada.

However, the dollar's anaemic response to the tax cuts also suggests that investors believe that the reform will result in higher inflation, rather than in faster long-term economic growth or more aggressive tightening by the Fed. Indeed, the minutes from the Fed's December meeting show little change in its monetary policy outlook despite an upgrade to its growth forecasts, and inflation premiums on long-term bond yields have risen significantly over the past month.

The Economist Intelligence Unit's view for some time has been that investors are underestimating the willingness of the Fed to raise interest rates over the next two years. Markets have priced in two 25-basis-point rate increases in 2018; we expect three, and now forecast that the Fed will shift to a slightly more aggressive stance in 2019, with four more rate rises in that year. On its own, this should provide the dollar with fresh support over the next two years. However, as the global economic expansion continues, a rising number of other central banks will also consider withdrawing stimulus. The value of the dollar will depend on the balance of these forces, and any rally in 2018-19 is likely to be modest at most. The dollar will also continue to be vulnerable to erratic policy-making and any quarters of poor economic growth. Beyond 2020 the outlook for the dollar is unambiguously negative, as the US business cycle turns and the Fed begins to cut interest rates.